Cost Accounting. Charles T. Horngren Stanford University. Srikant M. Datar Harvard University. Madhav V. Rajan Stanford University

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2 Cost Accounting A Managerial Emphasis Fourteenth Edition Charles T. Horngren Stanford University Srikant M. Datar Harvard University Madhav V. Rajan Stanford University Prentice Hall Boston Columbus Indianapolis New York San Francisco Upper Saddle River Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montréal Toronto Delhi Mexico City São Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

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4 Brief Contents 1 The Manager and Management Accounting 2 2 An Introduction to Cost Terms and Purposes 26 3 Cost-Volume-Profit Analysis 62 4 Job Costing 98 5 Activity-Based Costing and Activity-Based Management Master Budget and Responsibility Accounting Flexible Budgets, Direct-Cost Variances, and Management Control Flexible Budgets, Overhead Cost Variances, and Management Control Inventory Costing and Capacity Analysis Determining How Costs Behave Decision Making and Relevant Information Pricing Decisions and Cost Management Strategy, Balanced Scorecard, and Strategic Profitability Analysis Cost Allocation, Customer-Profitability Analysis, and Sales-Variance Analysis Allocation of Support-Department Costs, Common Costs, and Revenues Cost Allocation: Joint Products and Byproducts Process Costing Spoilage, Rework, and Scrap Balanced Scorecard: Quality, Time, and the Theory of Constraints Inventory Management, Just-in-Time, and Simplified Costing Methods Capital Budgeting and Cost Analysis Management Control Systems, Transfer Pricing, and Multinational Considerations Performance Measurement, Compensation, and Multinational Considerations 806 iii

5 Contents 1 The Manager and Management Accounting 2 itunes Variable Pricing: Downloads Are Down, but Profits Are Up Financial Accounting, Management Accounting, and Cost Accounting 3 Strategic Decisions and the Management Accountant 5 Value Chain and Supply Chain Analysis and Key Success Factors 5 Value-Chain Analysis 6 Supply-Chain Analysis 7 Key Success Factors 7 Decision Making, Planning, and Control: The Five-Step Decision-Making Process 9 Key Management Accounting Guidelines 11 Cost-Benefit Approach 12 Behavioral and Technical Considerations 12 Different Costs for Different Purposes 12 Organization Structure and the Management Accountant 13 Line and Staff Relationships 13 The Chief Financial Officer and the Controller 13 Professional Ethics 14 Institutional Support 14 Concepts in Action: Management Accounting Beyond the Numbers Typical Ethical Challenges 17 Problem for Self-Study 18 Decision Points 18 Terms to Learn 19 Assignment Material 19 Questions 19 Exercises 20 Problems 22 Collaborative Learning Problem 25 2 An Introduction to Cost Terms and Purposes 26 GM Collapses Under the Weight of its Fixed Costs Costs and Cost Terminology 27 Direct Costs and Indirect Costs 28 Challenges in Cost Allocation 29 Factors Affecting Direct/Indirect Cost Classifications 29 Cost-Behavior Patterns: Variable Costs and Fixed Costs 30 Cost Drivers 32 Concepts in Action: How Zipcar Helps Reduce Twitter s Transportation Costs Relevant Range 33 Relationships of Types of Costs 34 Total Costs and Unit Costs 35 Unit Costs 35 Use Unit Costs Cautiously 35 Business Sectors, Types of Inventory, Inventoriable Costs, and Period Costs 36 Manufacturing-, Merchandising-, and Service-Sector Companies 36 Types of Inventory 37 Commonly Used Classifications of Manufacturing Costs 37 Inventoriable Costs 37 Period Costs 38 Illustrating the Flow of Inventoriable Costs and Period Costs 39 Manufacturing-Sector Example 39 Recap of Inventoriable Costs and Period Costs 42 Prime Costs and Conversion Costs 43 Measuring Costs Requires Judgment 44 Measuring Labor Costs 44 Overtime Premium and Idle Time 44 Benefits of Defining Accounting Terms 45 Different Meanings of Product Costs 45 A Framework for Cost Accounting and Cost Management 47 Calculating the Cost of Products, Services, and Other Cost Objects 47 Obtaining Information for Planning and Control and Performance Evaluation 47 Analyzing the Relevant Information for Making Decisions 47 Problem for Self-Study 48 Decision Points 50 Terms to Learn 51 Assignment Material 51 Questions 51 Exercises 52 Problems 56 Collaborative Learning Problem 61 3 Cost-Volume-Profit Analysis 62 How the The Biggest Rock Show Ever Turned a Big Profit Essentials of CVP Analysis 63 Contribution Margins 64 Expressing CVP Relationships 66 Cost-Volume-Profit Assumptions 68 Breakeven Point and Target Operating Income 68 Breakeven Point 68 Target Operating Income 69 Target Net Income and Income Taxes 70 Using CVP Analysis for Decision Making 72 Decision to Advertise 72 Decision to Reduce Selling Price 73 iv

6 CONTENTS V Sensitivity Analysis and Margin of Safety 73 Cost Planning and CVP 75 Alternative Fixed-Cost/Variable-Cost Structures 75 Operating Leverage 76 Effects of Sales Mix on Income 77 Concepts in Action: Fixed Costs, Variable Costs, and the Future of Radio CVP Analysis in Service and Nonprofit Organizations 80 Contribution Margin Versus Gross Margin 81 Problem for Self-Study 82 Decision Points 83 APPENDIX: Decision Models and Uncertainty 84 Terms to Learn 86 Assignment Material 87 Questions 87 Exercises 87 Problems 91 Collaborative Learning Problem 97 4 Job Costing 98 Job Costing and Nexamp s Next Generation Energy and Carbon Solutions Building-Block Concepts of Costing Systems 99 Job-Costing and Process-Costing Systems 100 Job Costing: Evaluation and Implementation 102 Time Period Used to Compute Indirect-Cost Rates 103 Normal Costing 104 General Approach to Job Costing 104 Concepts in Action: Job Costing on Cowboys Stadium The Role of Technology 109 Actual Costing 110 A Normal Job-Costing System in Manufacturing 111 General Ledger 112 Explanations of Transactions 113 Subsidiary Ledgers 114 Budgeted Indirect Costs and End-of-Accounting-Year Adjustments 117 Underallocated and Overallocated Direct Costs 118 Adjusted Allocation-Rate Approach 118 Proration Approach 119 Write-Off to Cost of Goods Sold Approach 121 Choice Among Approaches 121 Variations from Normal Costing: A Service-Sector Example 122 Problem for Self-Study 123 Decision Points 125 Terms to Learn 126 Assignment Material 126 Questions 126 Exercises 127 Problems 132 Collaborative Learning Problem Activity-Based Costing and Activity- Based Management 138 LG Electronics Reduces Costs and Inefficiencies Through Activity-Based Costing Broad Averaging and Its Consequences 139 Undercosting and Overcosting 140 Product-Cost Cross-Subsidization 140 Simple Costing System at Plastim Corporation 141 Design, Manufacturing, and Distribution Processes 141 Simple Costing System Using a Single Indirect-Cost Pool 142 Applying the Five-Step Decision-Making Process at Plastim 144 Refining a Costing System 145 Reasons for Refining a Costing System 145 Guidelines for Refining a Costing System 146 Activity-Based Costing Systems 146 Plastim s ABC System 146 Cost Hierarchies 149 Implementing Activity-Based Costing 150 Implementing ABC at Plastim 150 Comparing Alternative Costing Systems 153 Considerations in Implementing Activity-Based- Costing Systems 154 Concepts in Action: Successfully Championing ABC Using ABC Systems for Improving Cost Management and Profitability 156 Pricing and Product-Mix Decisions 156 Cost Reduction and Process Improvement Decisions 156 Design Decisions 157 Planning and Managing Activities 158 Activity-Based Costing and Department Costing Systems 158 ABC in Service and Merchandising Companies 159 Concepts in Action: Time-Driven Activity-Based Costing at Charles Schwab Problem for Self-Study 160 Decision Points 163 Terms to Learn 164 Assignment Material 164 Questions 164 Exercises 165 Problems 172 Collaborative Learning Problem Master Budget and Responsibility Accounting 182 Scrimping at the Ritz: Master Budgets Budgets and the Budgeting Cycle 184 Strategic Plans and Operating Plans 184 Budgeting Cycle and Master Budget 185 Advantages of Budgets 185 Coordination and Communication 185 Framework for Judging Performance and Facilitating Learning 186 Motivating Managers and Other Employees 186 Challenges in Administering Budgets 187 Developing an Operating Budget 187 Time Coverage of Budgets 187 Steps in Preparing an Operating Budget 188 Financial Planning Models and Sensitivity Analysis 197 Concepts in Action: Web-Enabled Budgeting and Hendrick Motorsports Budgeting and Responsibility Accounting 199

7 VI CONTENTS Organization Structure and Responsibility 199 Feedback 200 Responsibility and Controllability 200 Human Aspects of Budgeting 201 Budgetary Slack 201 Kaizen Budgeting 203 Budgeting in Multinational Companies 203 Problem for Self-Study 204 Decision Points 205 APPENDIX: The Cash Budget 206 Terms to Learn 211 Assignment Material 211 Questions 211 Exercises 211 Problems 215 Collaborative Learning Problem Flexible Budgets, Direct-Cost Variances, and Management Control 226 The NBA: Where Frugal Happens Static Budgets and Variances 227 The Use of Variances 227 Static Budgets and Static-Budget Variances 228 Flexible Budgets 230 Flexible-Budget Variances and Sales-Volume Variances 231 Sales-Volume Variances 232 Flexible-Budget Variances 233 Price Variances and Efficiency Variances for Direct-Cost Inputs 234 Obtaining Budgeted Input Prices and Budgeted Input Quantities 234 Data for Calculating Webb s Price Variances and Efficiency Variances 235 Price Variances 236 Efficiency Variance 236 Concepts in Action: Starbucks Reduces Direct-Cost Variances to Brew a Turnaround Summary of Variances 239 Journal Entries Using Standard Costs 240 Implementing Standard Costing 241 Standard Costing and Information Technology 241 Wide Applicability of Standard Costing 242 Management Uses of Variances 242 Multiple Causes of Variances 242 When to Investigate Variances 242 Performance Measurement Using Variances 243 Organization Learning 243 Continuous Improvement 244 Financial and Nonfinancial Performance Measures 244 Benchmarking and Variance Analysis 244 Problem for Self-Study 246 Decision Points 247 APPENDIX: Market-Share and Market-Size Variances 248 Terms to Learn 249 Assignment Material 250 Questions 250 Exercises 250 Problems 254 Collaborative Learning Problem Flexible Budgets, Overhead Cost Variances, and Management Control 262 Overhead Cost Variances Force Macy s to Shop for Changes in Strategy Planning of Variable and Fixed Overhead Costs 263 Planning Variable Overhead Costs 264 Planning Fixed Overhead Costs 264 Standard Costing at Webb Company 264 Developing Budgeted Variable Overhead Rates 265 Developing Budgeted Fixed Overhead Rates 266 Variable Overhead Cost Variances 267 Flexible-Budget Analysis 267 Variable Overhead Efficiency Variance 267 Variable Overhead Spending Variance 269 Journal Entries for Variable Overhead Costs and Variances 270 Fixed Overhead Cost Variances 271 Production-Volume Variance 272 Interpreting the Production-Volume Variance 273 Journal Entries for Fixed Overhead Costs and Variances 274 Integrated Analysis of Overhead Cost Variances Variance Analysis 277 Combined Variance Analysis 278 Production-Volume Variance and Sales-Volume Variance 278 Concepts in Action: Variance Analysis and Standard Costing Help Sandoz Manage Its Overhead Costs Variance Analysis and Activity-Based Costing 281 Flexible Budget and Variance Analysis for Direct Labor Costs 282 Flexible Budget and Variance Analysis for Fixed Setup Overhead Costs 284 Overhead Variances in Nonmanufacturing Settings 285 Financial and Nonfinancial Performance Measures 286 Problem for Self-Study 287 Decision Points 289 Terms to Learn 290 Assignment Material 290 Questions 290 Exercises 290 Problems 294 Collaborative Learning Problem Inventory Costing and Capacity Analysis 300 Lean Manufacturing Helps Companies Reduce Inventory and Survive the Recession Variable and Absorption Costing 301 Variable Costing 301 Absorption Costing 302 Comparing Variable and Absoption Costing 302 Variable vs. Absorption Costing: Operating Income and Income Statements 303 Comparing Income Statements for One Year 303 Comparing Income Statements for Three Years 305

8 CONTENTS VII Variable Costing and the Effect of Sales and Production on Operating Income 308 Absorption Costing and Performance Measurement 309 Undesirable Buildup of Inventories 310 Proposals for Revising Performance Evaluation 311 Comparing Inventory Costing Methods 312 Throughput Costing 312 A Comparison of Alternative Inventory-Costing Methods 313 Denominator-Level Capacity Concepts and Fixed-Cost Capacity Analysis 314 Absorption Costing and Alternative Denominator- Level Capacity Concepts 314 Effect on Budgeted Fixed Manufacturing Cost Rate 315 Choosing a Capacity Level 316 Product Costing and Capacity Management 316 Pricing Decisions and the Downward Demand Spiral 317 Performance Evaluation 318 Concepts in Action: The Death Spiral and the End of Landline Telephone Service External Reporting 320 Tax Requirements 322 Planning and Control of Capacity Costs 323 Difficulties in Forecasting Chosen Denominator-Level Concept 323 Difficulties in Forecasting Fixed Manufacturing Costs 323 Nonmanufacturing Costs 324 Activity-Based Costing 324 Problem for Self-Study 324 Decision Points 326 APPENDIX: Breakeven Points in Variable Costing and Absorption Costing 327 Terms to Learn 328 Assignment Material 328 Questions 328 Exercises 329 Problems 334 Collaborative Learning Problem Determining How Costs Behave 340 Management Accountants at Cisco Embrace Opportunities, Enhance Sustainability Basic Assumptions and Examples of Cost Functions 341 Basic Assumptions 342 Linear Cost Functions 342 Review of Cost Classification 343 Identifying Cost Drivers 344 The Cause-and-Effect Criterion 345 Cost Drivers and the Decision-Making Process 345 Cost Estimation Methods 346 Industrial Engineering Method 346 Conference Method 346 Account Analysis Method 347 Quantitative Analysis Method 347 Steps in Estimating a Cost Function Using Quantitative Analysis 348 High-Low Method 350 Regression Analysis Method 352 Evaluating Cost Drivers of the Estimated Cost Function 353 Choosing Among Cost Drivers 354 Concepts in Action: Activity-Based Costing: Identifying Cost and Revenue Drivers Cost Drivers and Activity-Based Costing 356 Nonlinear Cost Functions 357 Learning Curves 358 Cumulative Average-Time Learning Model 359 Incremental Unit-Time Learning Model 360 Incorporating Learning-Curve Effects into Prices and Standards 361 Data Collection and Adjustment Issues 362 Problem for Self-Study 364 Decision Points 366 APPENDIX: Regression Analysis 367 Terms to Learn 375 Assignment Material 375 Questions 375 Exercises 375 Problems 382 Collaborative Learning Problem Decision Making and Relevant Information 390 Relevant Costs, JetBlue, and Twitter Information and the Decision Process 391 The Concept of Relevance 392 Relevant Costs and Relevant Revenues 393 Qualitative and Quantitative Relevant Information 394 An Illustration of Relevance: Choosing Output Levels 394 One-Time-Only Special Orders 394 Potential Problems in Relevant-Cost Analysis 397 Insourcing-versus-Outsourcing and Make-versus-Buy Decisions 397 Outsourcing and Idle Facilities 397 Strategic and Qualitative Factors 399 Concepts in Action: Pringles Prints and the Offshoring of Innovation International Outsourcing 400 Opportunity Costs and Outsourcing 401 The Opportunity-Cost Approach 402 Carrying Costs of Inventory 403 Product-Mix Decisions with Capacity Constraints 405 Customer Profitability, Activity-Based Costing, and Relevant Costs 406 Relevant-Revenue and Relevant-Cost Analysis of Dropping a Customer 408 Relevant-Revenue and Relevant-Cost Analysis of Adding a Customer 409 Relevant-Revenue and Relevant-Cost Analysis of Closing or Adding Branch Offices or Segments 409

9 VIII CONTENTS Irrelevance of Past Costs and Equipment-Replacement Decisions 410 Decisions and Performance Evaluation 412 Problem for Self-Study 413 Decision Points 415 APPENDIX: Linear Programming 416 Terms to Learn 418 Assignment Material 419 Questions 419 Exercises 419 Problems 424 Collaborative Learning Problem Pricing Decisions and Cost Management 432 Target Pricing and Tata Motors $2,500 Car Major Influences on Pricing Decisions 433 Customers, Competitors, and Costs 434 Costing and Pricing for the Short Run 434 Relevant Costs for Short-Run Pricing Decisions 435 Strategic and Other Factors in Short-Run Pricing 435 Effect of Time Horizon on Short-Run Pricing Decisions 435 Costing and Pricing for the Long Run 436 Calculating Product Costs for Long-Run Pricing Decisions 436 Alternative Long-Run Pricing Approaches 437 Target Costing for Target Pricing 439 Understanding Customers Perceived Value 439 Doing Competitor Analysis 439 Implementing Target Pricing and Target Costing 440 Concepts in Action: Extreme Target Pricing and Cost Management at IKEA Value Engineering, Cost Incurrence, and Locked-In Costs 442 Value-Chain Analysis and Cross-Functional Teams 442 Achieving the Target Cost per Unit for Provalue 443 Cost-Plus Pricing 445 Cost-Plus Target Rate of Return on Investment 445 Alternative Cost-Plus Methods 446 Cost-Plus Pricing and Target Pricing 447 Life-Cycle Product Budgeting and Costing 447 Life-Cycle Budgeting and Pricing Decisions 448 Customer Life-Cycle Costing 449 Additional Considerations for Pricing Decisions 450 Price Discrimination 450 Peak-Load Pricing 450 International Considerations 451 Antitrust Laws 451 Problem for Self-Study 452 Decision Points 454 Terms to Learn 455 Assignment Material 455 Questions 455 Exercises 456 Problems 460 Collaborative Learning Problem Strategy, Balanced Scorecard, and Strategic Profitability Analysis 466 Balanced Scorecard Helps Infosys Transform into a Leading Consultancy What Is Strategy? 467 Building Internal Capabilities: Quality Improvement and Reengineering at Chipset 469 Strategy Implementation and the Balanced Scorecard 470 The Balanced Scorecard 470 Strategy Maps and the Balanced Scorecard 471 Implementing a Balanced Scorecard 474 Aligning the Balanced Scorecard to Strategy 475 Features of a Good Balanced Scorecard 475 Pitfalls in Implementing a Balanced Scorecard 476 Evaluating the Success of Strategy and Implementation 477 Strategic Analysis of Operating Income 478 Growth Component of Change in Operating Income 479 Price-Recovery Component of Change in Operating Income 481 Productivity Component of Change in Operating Income 482 Further Analysis of Growth, Price-Recovery, and Productivity Components 483 Concepts in Action: The Growth Versus Profitability Choice at Facebook Applying the Five-Step Decision-Making Framework to Strategy 485 Downsizing and the Management of Processing Capacity 486 Engineered and Discretionary Costs 486 Identifying Unused Capacity for Engineered and Discretionary Overhead Costs 487 Managing Unused Capacity 487 Problem for Self-Study 488 Decision Points 492 APPENDIX: Productivity Measurement 492 Terms to Learn 495 Assignment Material 495 Questions 495 Exercises 495 Problems 498 Collaborative Learning Problem Cost Allocation, Customer-Profitability Analysis, and Sales-Variance Analysis 502 Minding the Store: Analyzing Customers, Best Buy Decides Not All Are Welcome Purposes of Cost Allocation 503 Criteria to Guide Cost-Allocation Decisions 504 Cost Allocation Decisions 506 Allocating Corporate Costs to Divisions and Products 508

10 CONTENTS IX Implementing Corporate Cost Allocations 509 Customer-Profitability Analysis 510 Customer-Revenue Analysis 511 Customer-Cost Analysis 511 Customer-Level Costs 512 Customer-Profitability Profiles 514 Presenting Profitability Analysis 515 Using the Five-Step Decision-Making Process to Manage Customer Profitability 517 Concepts in Action: iphone Apps Challenge Customer Profitability at AT&T Sales Variances 518 Static-Budget Variance 520 Flexible-Budget Variance and Sales-Volume Variance 520 Sales-Mix Variance 521 Sales-Quantity Variance 521 Problem for Self-Study 523 Decision Points 525 APPENDIX: Mix and Yield Variances for Substitutable Inputs 525 Terms to Learn 528 Assignment Material 529 Questions 529 Exercises 529 Problems 534 Collaborative Learning Problem Allocation of Support-Department Costs, Common Costs, and Revenues 542 Cost Allocation and the Future of Smart Grid Energy Infrastructure Allocating Support Department Costs Using the Single- Rate and Dual-Rate Methods 543 Single-Rate and Dual-Rate Methods 544 Allocation Based on the Demand for (or Usage of) Computer Services 544 Allocation Based on the Supply of Capacity 545 Single-Rate Versus Dual-Rate Method 546 Budgeted Versus Actual Costs, and the Choice of Allocaton Base 547 Budgeted Versus Actual Rates 547 Budgeted Versus Actual Usage 548 Allocating Costs of Multiple Support Departments 550 Direct Method 550 Step-Down Method 551 Reciprocal Method 553 Overview of Methods 556 Allocating Common Costs 557 Stand-Alone Cost-Allocation Method 557 Incremental Cost-Allocation Method 557 Cost Allocations and Contract Disputes 558 Contracting with the U.S. Government 559 Fairness of Pricing 559 Concepts in Action: Contract Disputes over Reimbursable Costs for the U.S. Department of Defense Bundled Products and Revenue Allocation Methods 560 Bundling and Revenue Allocation 560 Stand-Alone Revenue-Allocation Method 561 Incremental Revenue-Allocation Method 562 Problem for Self-Study 564 Decision Points 566 Terms to Learn 566 Assignment Material 567 Questions 567 Exercises 567 Problems 571 Collaborative Learning Problem Cost Allocation: Joint Products and Byproducts 576 Joint Cost Allocation and the Production of Ethanol Fuel Joint-Cost Basics 577 Allocating Joint Costs 579 Approaches to Allocating Joint Costs 579 Sales Value at Splitoff Method 580 Physical-Measure Method 582 Net Realizable Value Method 583 Constant Gross-Margin Percentage NRV Method 584 Choosing an Allocation Method 586 Not Allocating Joint Costs 587 Irrelevance of Joint Costs for Decision Making 587 Sell-or-Process-Further Decisions 587 Joint-Cost Allocation and Performance Evaluation 588 Pricing Decisions 589 Accounting for Byproducts 589 Concepts in Action: Byproduct Costing Keeps Wendy s Chili Profitable... and on the Menu Production Method: Byproducts Recognized at Time Production Is Completed 591 Sales Method: Byproducts Recognized at Time of Sale 592 Problem for Self-Study 592 Decision Points 595 Terms to Learn 596 Assignment Material 596 Questions 596 Exercises 596 Problems 601 Collaborative Learning Problem Process Costing 606 ExxonMobil and Accounting Differences in the Oil Patch Illustrating Process Costing 607 Case 1: Process Costing with No Beginning or Ending Work-in-Process Inventory 608 Case 2: Process Costing with Zero Beginning and Some Ending Work-in-Process Inventory 609 Physical Units and Equivalent Units (Steps 1 and 2) 610 Calculation of Product Costs (Steps 3, 4, and 5) 611 Journal Entries 612 Case 3: Process Costing with Some Beginning and Some Ending Work-in-Process Inventory 613 Weighted-Average Method 614 First-In, First-Out Method 617

11 X CONTENTS Comparison of Weighted-Average and FIFO Methods 620 Transferred-In Costs in Process Costing 621 Transferred-In Costs and the Weighted-Average Method 622 Transferred-In Costs and the FIFO Method 624 Points to Remember About Transferred-In Costs 625 Hybrid Costing Systems 626 Overview of Operation-Costing Systems 626 Concepts in Action: Hybrid Costing for Customized Shoes at Adidas Illustration of an Operation-Costing System 627 Journal Entries 629 Problem for Self-Study 630 Decision Points 631 APPENDIX: Standard-Costing Method of Process Costing 632 Terms to Learn 636 Assignment Material 636 Questions 636 Exercises 636 Problems 640 Collaborative Learning Problem Spoilage, Rework, and Scrap 644 Rework Delays the Boeing Dreamliner by Three Years Defining Spoilage, Rework and Scrap 645 Two Types of Spoilage 646 Normal Spoilage 646 Abnormal Spoilage 646 Spoilage in Process Costing Using Weighted-Average and FIFO 647 Count All Spoilage 647 Five-Step Procedure for Process Costing with Spoilage 648 Weighted-Average Method and Spoilage 649 FIFO Method and Spoilage 649 Journal Entries 652 Inspection Points and Allocating Costs of Normal Spoilage 652 Job Costing and Spoilage 655 Job Costing and Rework 656 Accounting for Scrap 657 Recognizing Scrap at the Time of Its Sale 657 Recognizing Scrap at the Time of Its Production 658 Concepts in Action: Managing Waste and Environmental Costs at KB Home Problem for Self-Study 660 Decision Points 660 APPENDIX: Standard-Costing Method and Spoilage 661 Terms to Learn 663 Assignment Material 663 Questions 663 Exercises 663 Problems 666 Collaborative Learning Problem Balanced Scorecard: Quality, Time, and the Theory of Constraints 670 Toyota Plans Changes After Millions of Defective Cars Are Recalled Quality as a Competitive Tool 671 The Financial Perspective: Costs of Quality 672 The Customer Perspective: Nonfinancial Measures of Customer Satisfaction 675 The Internal-Business-Process Perspective: Analyzing Quality Problems and Improving Quality 675 Nonfinancial Measures of Internal-Business-Process Quality 678 The Learning-and-Growth Perspective: Quality Improvements 678 Making Decisions and Evaluating Quality Performance 678 Time as a Competitive Tool 680 Customer-Response Time and On-Time Performance 681 Bottlenecks and Time Drivers 682 Concepts in Action: Overcoming Wireless Data Bottlenecks Relevant Revenues and Relevant Costs of Time 684 Theory of Constraints and Throughput-Margin Analysis 686 Managing Bottlenecks 686 Balanced Scorecard and Time-Related Measures 688 Problem for Self-Study 689 Decision Points 690 Terms to Learn 691 Assignment Material 691 Questions 691 Exercises 691 Problems 696 Collaborative Learning Problem Inventory Management, Just-in-Time, and Simplified Costing Methods 702 Costco Aggressively Manages Inventory to Thrive in Tough Times Inventory Management in Retail Organizations 703 Costs Associated with Goods for Sale 703 Economic-Order-Quantity Decision Model 704 When to Order, Assuming Certainty 707 Safety Stock 707 Estimating Inventory-Related Relevant Costs and Their Effects 709 Considerations in Obtaining Estimates of Relevant Costs 709 Cost of a Prediction Error 709 Conflict Between the EOQ Decision Model and Managers Performance Evaluation 710 Just-in-Time Purchasing 711 JIT Purchasing and EOQ Model Parameters 711 Relevant Costs of JIT Purchasing 711 Supplier Evaluation and Relevant Costs of Quality and Timely Deliveries 712

12 CONTENTS XI JIT Purchasing, Planning and Control, and Supply- Chain Analysis 713 Inventory Management, MRP and JIT Production 714 Materials Requirements Planning 714 JIT Production 715 Features of JIT Production Systems 715 Financial Benefits of JIT and Relevant Costs 715 JIT in Service Industries 716 Enterprise Resource Planning (ERP) Systems 716 Concepts in Action: After the Encore: Just-in-Time Live Concert Recordings Performance Measures and Control in JIT Production 718 Effect of JIT Systems on Product Costing 718 Backflush Costing 718 Simplified Normal or Standard Costing Systems 718 Accounting for Variances 722 Special Considerations in Backflush Costing 726 Lean Accounting 726 Problem for Self-Study 728 Decision Points 729 Terms to Learn 730 Assignment Material 731 Questions 731 Exercises 731 Problems 734 Collaborative Learning Problem Capital Budgeting and Cost Analysis 738 Target s Capital Budgeting Hits the Bull s-eye Stages of Capital Budgeting 739 Discounted Cash Flow 741 Net Present Value Method 742 Internal Rate-of-Return Method 743 Comparison of Net Present Value and Internal Rateof-Return Methods 745 Sensitivity Analysis 745 Payback Method 746 Uniform Cash Flows 746 Nonuniform Cash Flows 747 Accrual Accounting Rate-of-Return Method 749 Relevant Cash Flows in Discounted Cash Flow Analysis 750 Relevant After-Tax Flows 750 Categories of Cash Flows 752 Project Management and Performance Evaluation 755 Post-Investment Audits 756 Performance Evaluation 756 Strategic Considerations in Capital Budgeting 757 Investment in Research and Development 757 Customer Value and Capital Budgeting 757 Concepts in Action: International Capital Budgeting at Disney Problem for Self-Study 759 Decision Points 761 APPENDIX: Capital Budgeting and Inflation 762 Terms to Learn 764 Assignment Material 764 Questions 764 Exercises 764 Problems 768 Collaborative Learning Problem 772 Answers to Exercises in Compound Interest (Exercise 21-16) Management Control Systems, Transfer Pricing, and Multinational Considerations 774 Symantec Wins $545 million Opinion in Transfer Pricing Dispute with the IRS Management Control Systems 775 Formal and Informal Systems 775 Effective Management Control 776 Decentralization 776 Benefits of Decentralization 777 Costs of Decentralization 778 Comparison of Benefits and Costs 779 Decentralization in Multinational Companies 779 Choices About Responsibility Centers 779 Transfer Pricing 780 Criteria for Evaluating Transfer Prices 780 Calculating Transfer Prices 781 An Illustration of Transfer Pricing 781 Market-Based Transfer Prices 784 Perfectly-Competitive-Market Case 784 Distress Prices 784 Imperfect Competition 785 Cost-Based Transfer Prices 785 Full-Cost Bases 785 Variable-Cost Bases 787 Hybrid Transfer Prices 787 Prorating the Difference Between Maximum and Minimum Transfer Prices 788 Negotiated Pricing 788 Dual Pricing 789 A General Guideline for Transfer-Pricing Situations 790 Multinational Transfer Pricing and Tax Considerations 791 Transfer Pricing for Tax Minimization 792 Concepts in Action: Transfer Pricing Dispute Temporarily Stops the Flow of Fiji Water Transfer Prices Designed for Multiple Objectives 793 Additional Issues in Transfer Pricing 794 Problem for Self-Study 794 Decision Points 796 Terms to Learn 797 Assignment Material 797 Questions 797 Exercises 798 Problems 801 Collaborative Learning Problem Performance Measurement, Compensation, and Multinational Considerations 806 Misalignment Between CEO Compensation and Performance at AIG Financial and Nonfinancial Performance Measures 807 Accounting-Based Measures for Business Units 808 Return on Investment 809

13 XII CONTENTS Residual Income 810 Economic Value Added 812 Return on Sales 813 Comparing Performance Measures 813 Choosing the Details of the Performance Measures 814 Alternative Time Horizons 814 Alternative Definitions of Investment 815 Alternative Asset Measurements 815 Target Levels of Performance and Feedback 818 Choosing Target Levels of Performance 818 Choosing the Timing of Feedback 818 Performance Measurement in Multinational Companies 819 Calculating the Foreign Division s ROI in the Foreign Currency 819 Calculating the Foreign Division s ROI in U.S. Dollars 820 Distinction Between Managers and Organization Units 821 The Basic Trade-Off: Creating Incentives Versus Imposing Risk 821 Intensity of Incentives and Financial and Nonfinancial Measurements 822 Benchmarks and Relative Performance Evaluation 823 Performance Measures at the Individual Activity Level 823 Executive Performance Measures and Compensation 824 Concepts in Action: Government Bailouts, Record Profits, and the 2009 Wall Street Compensation Dilemma Strategy and Levers of Control 826 Boundary Systems 826 Belief Systems 827 Interactive Control Systems 827 Problem for Self-Study 827 Decision Points 829 Terms to Learn 830 Assignment Material 830 Questions 830 Exercises 830 Problems 834 Collaborative Learning Problem 838 Appendix A 839 Appendix B: Recommended Readings available online Appendix C: Cost Accounting in Professional Examination available online Glossary 846 Author Index 857 Company Index 858 Subject Index 860

14 About the Authors Charles T. Horngren is the Edmund W. Littlefield Professor of Accounting, Emeritus, at Stanford University. A Graduate of Marquette University, he received his MBA from Harvard University and his PhD from the University of Chicago. He is also the recipient of honorary doctorates from Marquette University and DePaul University. A certified public accountant, Horngren served on the Accounting Principles Board for six years, the Financial Accounting Standards Board Advisory Council for five years, and the Council of the American Institute of Certified Public Accountants for three years. For six years, he served as a trustee of the Financial Accounting Foundation, which oversees the Financial Accounting Standards Board and the Government Accounting Standards Board. Horngren is a member of the Accounting Hall of Fame. A member of the American Accounting Association, Horngren has been its president and its director of research. He received its first Outstanding Accounting Educator Award. The California Certified Public Accountants Foundation gave Horngren its Faculty Excellence Award and its Distinguished Professor Award. He is the first person to have received both awards. The American Institute of Certified Public Accountants presented its first Outstanding Educator Award to Horngren. Horngren was named Accountant of the Year, Education, by the national professional accounting fraternity, Beta Alpha Psi. Professor Horngren is also a member of the Institute of Management Accountants, from whom he received its Distinguished Service Award. He was also a member of the Institutes Board of Regents, which administers the Certified Management Accountant examinations. Horngren is the author of other accounting books published by Prentice Hall: Introduction to Management Accounting, 15th ed. (2011, with Sundem and Stratton); Introduction to Financial Accounting, 10th ed. (2011, with Sundem and Elliott); Accounting, 8th ed. (2010, with Harrison and Bamber); and Financial Accounting, 8th ed. (2010, with Harrison). Horngren is the Consulting Editor for the Charles T. Horngren Series in Accounting. Srikant M. Datar is the Arthur Lowes Dickinson Professor of Business Administration and Senior Associate Dean at Harvard University. A graduate with distinction from the University of Bombay, he received gold medals upon graduation from the Indian Institute of Management, Ahmedabad, and the Institute of Cost and Works Accountants of India. A chartered accountant, he holds two master s degrees and a PhD from Stanford University. Cited by his students as a dedicated and innovative teacher, Datar received the George Leland Bach Award for Excellence in the Classroom at Carnegie Mellon University and the Distinguished Teaching Award at Stanford University. Datar has published his research in leading accounting, marketing, and operations management journals, including The Accounting Review, Contemporary Accounting Research, Journal of Accounting, Auditing and Finance, Journal of Accounting and Economics, Journal of Accounting Research, and Management Science. He has also served on the editorial board of several journals and presented his research to corporate executives and academic audiences in North America, South America, Asia, Africa, Australia, and Europe. Datar is a member of the board of directors of Novartis A.G., ICF International, KPIT Cummins Infosystems Ltd., Stryker Corporation, and Harvard Business Publishing, and has worked with many organizations, including Apple Computer, AT&T, Boeing, Du Pont, Ford, General Motors, HSBC, Hewlett-Packard, Morgan Stanley, PepsiCo, TRW, xiii

15 XIV ABOUT THE AUTHORS Visa, and the World Bank. He is a member of the American Accounting Association and the Institute of Management Accountants. Madhav V. Rajan is the Gregor G. Peterson Professor of Accounting and Senior Associate Dean at Stanford University. From 2002 to 2010, he was the area coordinator for accounting at Stanford s Graduate School of Business. Rajan received his undergraduate degree in commerce from the University of Madras, India, and his MS in accounting, MBA, and PhD degrees from the Graduate School of Industrial Administration at Carnegie Mellon University. In 1990, his dissertation won the Alexander Henderson Award for Excellence in Economic Theory. Rajan s primary area of research interest is the economics-based analysis of management accounting issues, especially as they relate to internal control cost allocation, capital budgeting, quality management, supply chain, and performance systems in firms. He has published his research in leading accounting and operations management journals including The Accounting Review, Review of Financial Studies, Journal of Accounting Research, and Management Science. In 2004, he received the Notable Contribution to Management Accounting Literature Award. Rajan has served as the Departmental Editor for Accounting at Management Science, as well as associate editor for both the accounting and operations areas. From 2002 to 2008, Rajan served as an editor of The Accounting Review. He is also currently an associate editor for the Journal of Accounting, Auditing and Finance. Rajan is a member of the management accounting section of the American Accounting Association and has twice been a plenary speaker at the AAA Management Accounting Conference. Rajan has won several teaching awards at Wharton and Stanford, including the David W. Hauck Award, the highest undergraduate teaching honor at Wharton. Rajan has taught in a variety of executive education programs including the Stanford Executive Program, the National Football League Program for Managers, and the National Basketball Players Association Program, as well as custom programs for firms including nvidia, Genentech, and Google.

16 Preface Studying Cost Accounting is one of the best business investments a student can make. Why? Because success in any organization from the smallest corner store to the largest multinational corporation requires the use of cost accounting concepts and practices. Cost accounting provides key data to managers for planning and controlling, as well as costing products, services, even customers. This book focuses on how cost accounting helps managers make better decisions, as cost accountants are increasingly becoming integral members of their company s decision-making teams. In order to emphasize this prominence in decision-making, we use the different costs for different purposes theme throughout this book. By focusing on basic concepts, analyses, uses, and procedures instead of procedures alone, we recognize cost accounting as a managerial tool for business strategy and implementation. We also prepare students for the rewards and challenges they face in the professional cost accounting world of today and tomorrow. For example, we emphasize both the development of analytical skills such as Excel to leverage available information technology and the values and behaviors that make cost accountants effective in the workplace. Hallmark Features of Cost Accounting Exceptionally strong emphasis on managerial uses of cost information Clarity and understandability of the text Excellent balance in integrating modern topics with traditional coverage Emphasis on human behavior aspects Extensive use of real-world examples Ability to teach chapters in different sequences Excellent quantity, quality, and range of assignment material The first thirteen chapters provide the essence of a one-term (quarter or semester) course. There is ample text and assignment material in the book s twenty-three chapters for a two-term course. This book can be used immediately after the student has had an introductory course in financial accounting. Alternatively, this book can build on an introductory course in managerial accounting. Deciding on the sequence of chapters in a textbook is a challenge. Since every instructor has a unique way of organizing his or her course, we utilize a modular, flexible organization that permits a course to be custom tailored. This organization facilitates diverse approaches to teaching and learning. As an example of the book s flexibility, consider our treatment of process costing. Process costing is described in Chapters 17 and 18. Instructors interested in filling out a student s perspective of costing systems can move directly from job-order costing described in Chapter 4 to Chapter 17 without interruption in the flow of material. Other instructors may want their students to delve into activity-based costing and budgeting and more decision-oriented topics early in the course. These instructors may prefer to postpone discussion of process costing. New to This Edition Greater Emphasis on Strategy This edition deepens the book s emphasis on strategy development and execution. Several chapters build on the strategy theme introduced in Chapter 1. Chapter 13 has a greater discussion of strategy maps as a useful tool to implement the balanced scorecard and a xv

17 XVI PREFACE simplified presentation of how income statements of companies can be analyzed from the strategic perspective of product differentiation or cost leadership. We also discuss strategy considerations in the design of activity-based costing systems in Chapter 5, the preparation of budgets in Chapter 6, and decision making in Chapters 11 and 12. Deeper Consideration of Global Issues Business is increasingly becoming more global. Even small and medium-sized companies across the manufacturing, merchandising, and service sectors are being forced to deal with the effects of globalization. Global considerations permeate many chapters. For example, Chapter 11 discusses the benefits and the challenges that arise when outsourcing products or services outside the United States. Chapter 22 examines the importance of transfer pricing in minimizing the tax burden faced by multinational companies. Several new examples of management accounting applications in companies are drawn from international settings. Increased Focus on the Service Sector In keeping with the shifts in the U.S. and world economy this edition makes greater use of service sector examples. For example, Chapter 2 discusses the concepts around the measurement of costs in a software development rather than a manufacturing setting. Chapter 6 provides several examples of the use of budgets and targets in service companies. Several concepts in action boxes focus on the service sector such as activity-based costing at Charles Schwab (Chapter 5) and managing wireless data bottlenecks (Chapter 19). New Cutting Edge Topics The pace of change in organizations continues to be rapid. The fourteenth edition of Cost Accounting reflects changes occurring in the role of cost accounting in organizations. We have introduced foreign currency and forward contract issues in the context of outsourcing decisions. We have added ideas based on Six Sigma to the discussion of quality. We have rewritten the chapter on strategy and the balanced scorecard and simplified the presentation to connect strategy development, strategy maps, balanced scorecard, and analysis of operating income. We discuss current trends towards Beyond Budgeting and the use of rolling forecasts. We develop the link between traditional forms of cost allocation and the nascent movement in Europe towards Resource Consumption Accounting. We focus more sharply on how companies are simplifying their costing systems with the presentation of value streams and lean accounting. Opening Vignettes Each chapter opens with a vignette on a real company situation. The vignettes engage the reader in a business situation, or dilemma, illustrating why and how the concepts in the chapter are relevant in business. For example, Chapter 1 describes how Apple uses cost accounting information to make decisions relating to how they price the most popular songs on itunes. Chapter 3 explains how the band U2 paid for their extensive new stage by lowering ticket prices. Chapter 7 describes how even the NBA was forced to cut costs after over half of the league s franchises declared losses. Chapter 11 shows how JetBlue uses Twitter and to help their customers make better pricing decisions. Chapter 12 discusses how Tata Motors designed a car for the Indian masses, priced at only $2,500. Chapter 14 shows how Best Buy boosts profits by analyzing its customers and their buying habits. Chapter 18 describes how Boeing incurred great losses as it reworked its muchanticipated Dreamliner airplane.

18 PREFACE XVII Concepts in Action Boxes Found in every chapter, these boxes cover real-world cost accounting issues across a variety of industries including automobile racing, defense contracting, entertainment, manufacturing, and retailing. New examples include How Zipcar Helps Reduce Business Transportation Costs p. 33 Job Costing at Cowboys Stadium p. 108 The Death Spiral and the End of Landline Telephone Service p. 319 Transfer Pricing Dispute Temporarily Stops the Flow of Fiji Water p. 793 Streamlined Presentation We continue to try to simplify and streamline our presentation of various topics to make it as easy as possible for a student to learn the concepts, tools, and frameworks introduced in different chapters. Examples of more streamlined presentations can be found in Chapter 3 on the discussion of target net income Chapter 5 on the core issues in activity-based costing (ABC) Chapter 8, which uses a single comprehensive example to illustrate the use of variance analysis in ABC systems Chapter 13, which has a much simpler presentation of the strategic analysis of operating income Chapter 15, which uses a simpler, unified framework to discuss various cost-allocation methods Chapters 17 and 18, where the material on standard costing has been moved to the appendix, allowing for smoother transitions through the sections in the body of the chapter Selected Chapter-by-Chapter Content Changes Thank you for your continued support of Cost Accounting. In every new edition, we strive to update this text thoroughly. To ease your transition from the thirteenth edition, here are selected highlights of chapter changes for the fourteenth edition. Chapter 1 has been rewritten to focus on strategy, decision-making, and learning emphasizing the managerial issues that animate modern management accounting. It now emphasizes decision making instead of problem solving, performance evaluation instead of scorekeeping and learning instead of attention directing. Chapter 2 has been rewritten to emphasize the service sector. For example, instead of a manufacturing company context, the chapter uses the software development setting at a company like Apple Inc. to discuss cost measurement. It also develops ideas related to risk when discussing fixed versus variable costs. Chapter 3 has been rewritten to simplify the presentation of target net income by describing how target net income can be converted to target operating income. This allows students to use the equations already developed for target operating income when discussing target net income. We deleted the section on multiple cost drivers, because it is closely related to the multi-product example discussed in the chapter. The managerial and decision-making aspects of the chapter have also been strengthened. Chapter 4 has been reorganized to first discuss normal costing and then actual costing because normal costing is much more prevalent in practice. As a result of this change the exhibits in the early part of the chapter tie in more closely to the detailed exhibits of normal job-costing systems in manufacturing later in the chapter. The presentation of actual costing has been retained to help students understand the benefits and challenges of actual costing systems. To focus on job costing, we moved the discussion of responsibility centers and departments to Chapter 6.